Tangible Capital Assets Alberta Regional GFOA Workshops Series

Tangible Capital Assets Alberta Regional GFOA Workshops Series Two January 2008

Workshop Overview n n n n 2 Provincial and local updates Capital policy Impact on budgets and financial reports Transition Examples 2007 Note Q & A/small groups

TCA Project Update – Provincial n n n 3 Infrastructure valuation manual Bridge inventory & valuation Balanced budget legislation Financial reporting & budgets Position papers

Bridge Inventory & Valuation n n Access AIT bridge information Bridge files q q n 4 Inventory Data Value Accumulated amortization Audit trail

Guideline Amendments n n n 5 Capitalization thresholds Valuation date for counties Policy guideline - Amortization start and end date

Position Papers – Priority One n n n 6 Government partnerships Undeveloped road allowances and rights of way Networks/components – materiality, valuation Biological assets Grouping and pooling Contributed assets

Position Papers – Priority Two n Multiple topics q q q 7 Gravel pits Infrastructure with excess capacity and partial retirements Land leases Provincial $1 transfers Fully depreciated assets still in use Municipal reserves

Position Papers – Priority Two (cont) n Multiple topics q q q 8 Treatment of ‘sweat’ equity Tax sale properties acquired by municipality ‘Construction in progress’ Useful life and liability relationship Link to full cost recovery requirement by Environment

Position Papers – Priority Three n 9 Implementation accounting entries

TCA Project Update - Locally What is your project status? 10

Capital Policy Framework Scope Principles Presentation Thresholds Accounting Policy Aggregation Write-downs Disposals Segmentation Amortization 11

Capital Policy n n 12 Authority, purpose and scope Definition & classification of assets Recording and valuing assets Amortization methods and rates

Capital Policy (cont) n n n 13 Reviews and write-downs Maintaining records Asset disposal Financial system, asset recording system & asset management system Financial reporting and budgets

TCA Impact on Financial Statements & Budgets n n 14 Focus on TCA impact Financial reporting changes

General Impact of Recording TCA Brings a non-cash dimension to financial reporting and budgeting Full Accrual Accounting This change does not require a change in behaviour but it may cause you to change because there will be more information available. 15

Impacts at Transition and Ongoing n n n 16 Amount of TCA will probably increase. Total TCA will be reduced by ‘accumulated amortization’. Higher emphasis on Statement of Cash Flow.

Impacts at Transition and Ongoing Statement of Operations n TCA purchases not included n Capital grants included n Non-cash annual amortization expense n Gain/loss on disposal of TCA included n Write-downs expensed 17

What Will be the Impact to our Municipality? Each municipality will be different; some factors determining impact are: n Age of TCA q q n n 18 Net value of unrecorded TCA Accumulated amortization of recorded TCA Write-down of recorded TCA Assets funded by senior government and donated assets.

Should the budget mirror the financial statements? n n 19 Recommend that amortization expense be included in the budget. If not, PSAB requires a link between the budget and financial statements be provided.

Statement of Financial Position – Current View As at December 31 Financial Assets Cash and investments $ 480, 000 Accounts receivable 104, 000 Inventory for resale 155, 000 739, 000 Physical Assets Inventory for consumption Capital assets 5, 000 14, 003, 000 14, 008, 000 Total Assets 14, 747, 000 Liabilities Accounts payable 264, 000 Deferred revenue 56, 000 Long term debt 2, 900, 000 3, 220, 000 Municipal Equity Operating fund Capital fund Equity in capital assets 372, 000 42, 000 11, 113, 000 11, 527, 000 Total Liabilities & Municipal Equity 20 $ 14, 747, 000

Statement of Financial Position – New View As at December 31 Financial Assets Cash and investments $ 480, 000 Accounts receivable 104, 000 Inventory for resale 155, 000 739, 000 Liabilities Accounts payable 264, 000 Deferred revenue 56, 000 Long term debt 2, 900, 000 3, 220, 000 Net Debt (2, 481, 000) Non-financial Assets Inventory for consumption Tangible capital assets 5, 000 14, 003, 000 14, 008, 000 Accumulated Surplus 21 $ 11, 527, 000

Statement of Financial Activities/Operations As at December 31 Budget Current New Revenue Net municipal taxes $ 1, 430, 000 $ 1, 430, 000 Capital grants 200, 000 Capital debt issued 300, 000 1, 014, 000 2, 944, 000 2, 644, 000 2, 151, 000 Capital purchases 693, 000 Capital debt repayment 100, 000 Other revenue Expenditures Operating Amortization of TCA Excess (Deficiency) 2, 944, 000 2, 844, 000 2, 376, 000 0 (200, 000) 268, 000 Capital debt issued Capital debt repaid Change in Fund Balances 22 225, 000 300, 000 (100, 000) $ 0 $ 268, 000

Current Balanced Budget Legislation n n 23 Cannot budget more expenditures than anticipated revenues On a 3 year cumulative basis, actual revenue = or be > than expenditures (Sec 244) Revenue includes transfers from accumulated surplus Cash basis approach Operating and capital funds referenced

Impact of Accounting Standard Changes TCA Requirement (PS 3150) n n n 24 TCA to be amortized over useful life. Annual amortization (non-cash) to be expensed; may result in annual deficiencies. CICA requirement does not mandate funding amortization.

Impact of Accounting Standard Changes Financial Reporting (PS 1000, 1100, 1200) n n n 25 One single statement of operations Annual budget replaces operating & capital budgets Capital purchases/proceeds & debt proceeds/retirements are not included in ‘Statement of Operations’ ‘Accumulated surplus’ is one amount including ‘Equity in TCA’ Focus on financial position (net assets/net debt)

Proposed Amendments to Legislation and Future Review n Transitional Amendment q n Future Amendments q q n Replace references to operating & capital funds/budgets with ‘annual budget’ Consider redefining ‘deficiency’ Further Review q 26 Back out amortization expense to comply with Section 244 Measures of municipal financial performance including debt limits

Recording an Existing Asset Example An Arena built in 1940 has a 2006 appraisal cost of $10 M and a land value of $5 M. Component breakdown is as follows: Description % of cost Building Envelope 50% Roof 10% Mechanical 10% Interior Fit – outs 20% (includes ice sheet) Exterior Fit – outs 10% There is no salvage value. 27 Useful Life Remaining Useful Life 60 years 20 years 10 years 2 years 8 years 25 years 20 years

Discount Factor and Deflated Cost Discount Factor Index for in-service year/index for current year Deflated Cost Current cost * Discount Factor Example 1989 Discount Factor: 70. 9/112. 3 = 0. 631 Roof deflated cost: $1 M * 0. 631 = $631, 000 28

Discount Factors for Example 1940 0. 071 (8. 0/112. 3) 1989 0. 631 (70. 9/112. 3) 1999 0. 814 (91. 4/112. 3) 2002 0. 890 (100. 0/112. 3) 2005 0. 963 (108. 1/112. 3) 2006 1. 000 (112. 3/112. 3) 29

Inventory/Valuation Item Number 30 Item Description Replacement Reproduction or Appraisal Const Year Useful Life in Years Discount Factor Salvage Value 0. 071 Calculated Historical Cost 1 Land $5 M 1940 $0. 36 M 2 Building Envelope $5 M 1940 60 0. 071 $0 $0. 36 M 3 Roof $1 M 1989 20 0. 631 $0 $0. 63 M 4 Mechanical $1 M 2005 10 0. 963 $0 $0. 96 M 5 Interior Fit – outs $2 M 1999 10 0. 814 $0 $1. 63 M 6 Exterior Fit – outs $1 M 2002 25 0. 890 $0 $0. 89 M

Amortization Item Number 31 Item Description Historical Cost Age (Yrs) Useful Life in Years Amortization Rate (S/L) Amortization 1 Land $0. 36 M 67 2 Building Envelope $0. 36 M 67 60 * 60/60 $0. 36 M 3 Roof $0. 63 M 18 20 * 18/20 $0. 57 M 4 Mechanical $0. 96 M 2 10 * 2/10 $0. 19 M 5 Interior Fit – outs $1. 63 M 8 10 * 8/10 $1. 30 M 6 Exterior Fit – outs $0. 89 M 5 25 * 5/25 $0. 18 M

Qualitative Considerations 32 n What threshold(s) to use q Thresholds in ‘Toolkit’ q Cumulative? n Useful life considerations q Asset age exceeds useful life

Qualitative Considerations (cont) 33 n Discount Factor Used q CPI q Other n Supporting Information q Methodology q Valuation q Useful Life

Audit Support n Third Party Evidence q q n Industry Standards q q q 34 Invoice Qualified Estimator CPI Published lists Internally developed

Audit Support (cont) n Documented Methodology q q n 35 Consistent with methodology used by qualified third party Sound industry practice Reasonableness test

Transition Process n n n n 36 Develop TCA inventory and register information Record information in TCA register Document audit trail Determine accumulated amortization prior to implementation year Adjust General Ledger to implementation year opening balances Link TCA register to GL in implementation year (when all TCA are recorded) Record 2009 TCA transactions under new TCA rules and report in new reporting format

Transitional Impact Significant amendment to the financial statements in the first year of reporting due to: n n 37 Adding existing unrecorded TCA Deducting the recorded amount for TCA which no longer exist. Deducting the recorded amount for TCA having an historical cost below the capitalization threshold. Reporting the net value of the TCA total cost; deduct accumulated amortization.

Accumulated Amortization n 38 Identified by asset class in notes to financial statements. Amount prior to first year of reporting treated as a prior years’ adjustment. Annual amortization on the revised TCA expensed in year of implementation for that specific year.

Transition Accounting Entries Note: Journal entries are always balanced. Adjust Opening Balances of GL a. Reduce the existing TCA account balances to zero CR: Tangible capital assets DR: Capital debt DR: Equity in TCA – Prior period adjustment b. Record the updated TCA values DR: Tangible capital assets (historical cost) CR: Accumulated amortization CR: Capital debt CR: Equity in TCA – Prior period adjustment 39

Transition Accounting Entry Example Assumptions & Data n n Implement in 2009 GL accounts December 31, 2008: TCA Capital debt Equity in TCA n $10, 000 $2, 000 $8, 000 TCA data at implementation TCA historical cost $50, 000 Accumulated amortization $30, 000 40

Transition Accounting Entry Example (cont) a. 41 Reduce existing TCA account balances to zero: Dr Cr TCA $10, 000 Capital debt $2, 000 Equity in TCA $8, 000

Transition Accounting Entry Example (cont) b. 42 Record updated TCA inventory values: Dr Cr TCA $50, 000 Accumulated amortization $30, 000 Capital debt $2, 000 Equity in TCA $18, 000

Transition Accounting Entry Example (cont) n n n 43 The change in equity will be treated as a ‘prior period restatement/adjustment’ and referenced in the notes to the financial statements. If possible, record 2008 amortization in expense accounts for comparative statement purposes. Retroactive application – expected but not mandatory (CICA guide, pages 34 & 35)

‘Municipal Equity’ Terminology Current Terms (Sampleford) n Fund Balances q q q Operating Fund Capital Fund Reserve Fund Equity in Capital Assets New Term (used in examples) n Accumulated Surplus n 44

Purchase to Retirement Equipment – Fire truck (pumper) Information or Decisions Required Actual cost $300, 000 Useful life 12 years Amortization method Straight line Salvage value $60, 000 Annual amortization $20, 000 (assume ½ year rule for purchase and disposal years) 1 st year $10, 000 (50%) TCA asset register Major class Machinery & Equipment Minor class Fire Equipment Sub class Pumper truck 45

Purchase Entries Assume that there are links between General Ledger/Accounts Payable/TCA. DR TCA asset $300, 000 CR Cash/debt $300, 000 n No impact on Accumulated Surplus; there may be internal transfers between Equity in TCA and Reserves. n No record in Statement of Operations n Affects Statement of Financial Position 46

Amortization Expense Annual entry: DR Fire department – equipment amortization expense CR Accumulated amortization – Machinery & Equipment (1 st year - $10, 000, remaining years - $20, 000, disposal year if year 13 - $10, 000) n Annual closing entry DR Accumulated Surplus CR Fire department – equipment amortization expense Note: These entries demonstrate what will normally be done automatically by your financial system. n 47

Impact on Fire Department Budget If funds are normally collected annually for future purchases, i. e. transfer to capital: n amortization would be funded in the Statement of Operations; move budget from ‘transfer to capital’ to amortization n internal financial records would need to identify these funds n the department bottom line would be breakeven if the amount annually put away equalled the amortization. 48

Impact on Fire Department Budget If debt is normally used: n the fire department budget would incur an annual deficit of $20, 000 n cash would still need to be available in the organization to pay the debt which would be budgeted with no expense. q 49 If debt retirement allocated to the fire department, then offset the deficit resulting from the amortization expense.

Pumper Fire Truck Information at the end of Year 12 Cost $300, 000 Accumulated amortization $230, 000 Net book value $ 70, 000 Assume sold in year 13 Amortization entry in year 13 (50/50 rule) DR Fire Dept – Equipment amortization expense $10, 000 CR Accum. Amortization – M & E $10, 000 50

Sale & Disposal Entries in Year 13 Sold for $75, 000. DR Cash $ 75, 000 DR Accumulated amortization $240, 000 CR TCA asset $300, 000 CR Profit on disposal of TCA $ 15, 000 Annual Surplus and Accumulated Surplus will increase $15, 000. (TCA ($300, 000) less Accum. Amortization ($240, 000) less Cash ($75, 000) results in a credit of $15, 000 to Accumulated Surplus. 51

Example - Replacement of a Component Building Situation Information Building originally recorded at $5 M with a useful life of 40 years. Roof needs to be replaced in 2009: n The roof is fully amortized. n The life of the roof was 20 years. n Replacement cost is $1. 1 M. n Roof is 14% of the total building cost. 52

Replacement Entries DR Accumulated amortization $ 350, 000 DR Loss on disposal of roof $ 350, 000 CR TCA – Building $ 700, 000 DR TCA – Building – Roof $1, 100, 000 CR Cash/Debt $1, 100, 000 Loss on Statement of Operations Decrease in Accumulated Surplus 53

2009 Amortization Entries using 50% rule Old roof: $700, 000/40 * 50% New roof: $1, 100, 000/20*50% Total 2009 amortization expense 2009 Accumulated amortization 54 $ 8, 750 $27, 500 $36, 250 $27, 500

Impact of Amortization on Accumulated Surplus n n n Decrease if amortization expense is greater than roof related revenues Remain unchanged if amortization is funded. Increase if funds greater than annual amortization are put away for future roof replacement. Statement of Operations will reflect the changes in Accumulated Surplus in the annual deficit/surplus. 55

Issues to Consider n n 56 What are the audit issues if the roof is expensed? Is this cost material so that it will need to be capitalized? Is it better to record the cost of the major components at the time of initially recording the asset?

How Are Networks Determined? n n 57 Are the TCA in the proposed network similar? How is age determined? How will the value be established? Should the networks be determined by geographic location?

Example – Network to Segment Engineered Structure – Road System Situation Information The municipality has 20 km of paved roads. They have been recorded as networks; a separate network each for the asphalt, subsurface and right of way. The municipality plans to gradually segment each network when rehabilitation work is done. 58

Paved Road Information Historical Cost Description Asphalt 59 Total per km Useful Annual Replace Average Accumulated Life Amort. Cost Age Amortization Years per km Total per km 4 M 200, 000 15 13, 333 250, 000 10 2, 666, 667 133, 333 Subsurface 2. 5 M 125, 000 40 3, 125 850, 000 35 2, 187, 500 109, 375 Right of way 1 M 50, 000 0

Replace 2 km of Asphalt n n n 60 Replacement cost is $250, 000/km Assume component is fully amortized when replaced. Will set up a separate asset or multiple assets for the two km of asphalt.

Replacement Entries Remove asphalt component from TCA records DR Accumulated amortization $400, 000 (Asphalt – 2 km * 200, 000 historical cost) CR TCA – Engineered Structures – Roads - Asphalt $400, 000 61

New TCA Records n n 62 Create new TCA records in TCA register to provide more detailed information Segments – geographical location and distance established by policy (for example, by block or km)

Impact on TCA Network Records n n n 63 Since the asphalt network is the only network affected, the other networks will not be affected. The other networks may be segmented in the same manner as the asphalt network. If the asphalt, subsurface and right of way were one network, a new asset should be created for the subsurface portion for this specific segment with TCA and accumulated amortization adjustments made to the subsurface network.

Discussion Questions n n n 64 When networks are used, what methods can be used to determine the average life of the network and the accumulated amortization? What criteria should be used to determine the best method? What is the best method?

Reporting Requirements Prior to Implementation (PS 3150. 45) n Report according to PSG-7 during the period of transition. n PSG-7 TCA of Local Governments (Toolkit, page 55) q q 65 Disclose information required for asset classes for which municipality has information. Effective January 1, 2007

2009 (PS 3150. 40 -42) Disclose for each major category of TCA and in total: Beginning and end of period Cost, accumulated amortization, net carrying amount For the period Additions, disposals, write-downs, amortization Amortization method, period/rate 66

2009 (PS 3150. 40 -42) (cont) n n n 67 Net book value of TCA not amortized (not in service, under construction) Nature & amount of contributed TCA received during period Nature & use of TCA recognized at nominal value Nature of works of art & historical treasures Amount of interest capitalized in the period

2007 Financial Statement Note Section 6, TCA Implementation Toolkit n Subsection of ‘Significant Accounting Policies’ note n Narrative provides authority, background and progress report n Table provides the revised TCA information by major class Note: This table will not link to the TCA amount in Statement of Financial Position. TCA GL accounts are not revised until implementation. 68

2007 Financial Statement Note Example i. Narrative q q q 69 Assets already amortized noting amortization method. Assets not amortized if some are amortized. Assets classes completely updated. Asset classes still requiring to be completed by December 31, 2008 (2009) Assets disclosed at nominal value Statement regarding capitalizing interest (municipality policy)

2007 Financial Statement Note Example (cont) ii. List of TCA Classes q q 70 State that amortization expense not recorded and project the date when it will be recorded. List major classes and minor Engineered Structure classes. Provide range of useful life in years for each class reported. State method of amortization

2007 Financial Statement Note Example (cont) iii. Table of Financial Information q q q 71 Table for current year Table for previous year only if TCA project was started in previous year. Beginning year amount to be zero in year respective TCA class is completed. Amount of amortization in financial statements in situations where there has been amortization already in place. Value of assets not amortized because removed from service

2007 Financial Statement Note Example (cont) Cost - Beginning of Year Land Additions Disposal Write- End of Amortization Accumulated s downs Year in Year Amortization NBV 0 250, 000 0 125, 000 93, 750 31, 250 0 0 Land Improvements Buildings Engineered Structures Machinery & Equipment Vehicles Sub-total and Total 72 0 375, 000 93, 750 281, 250

Discussion Question How will accumulated amortization be tracked for asset classes completed prior to implementation? 73

Note for Prior Period Adjustments n n Restated to comply with PS 3150 Adjustments to TCA and Accumulated Surplus q q 74 Adjust opening 2008 if retroactive If not retroactive, adjust opening 2009

Note for Prior Period Adjustments n Add the net amount for q q q n Less q 75 Assets capitalized but previously expensed Contributed assets not recorded Disposal of assets Write-down of assets Assets capitalized but below threshold Increase in amortization expense

It’s Your Turn! 76